Digital options

Digital options produce a payout if the spot price meets or exceeds the selected barrier price at expiration.

Let’s imagine you buy a digital option for 105.00 USD/JPY that expires 10 days forward when spot is trading at 104.00. In the next nine days, USD/JPY may be trading comfortably above the 105.00 barrier between 105.50 and 105.90. However, if on expiration day USD/JPY slips below 105.00 and ends the day at 104.99, the trader would forfeit the entire premium.

Accordingly, digital options are less expensive than one-touch options with the same strike and expiration date.

Digital premiums can be half the price of no-touch options premiums with the exact same strike price and expiration dates, but the trader has to weigh the advantage of lower cost against the risk price will settle even 1 pip below the target at expiration.

In certain respects digital options resemble the vertical spread in vanilla options, where the trader buys a put or a call and offsets it by selling a cheaper put or call a strike higher/lower. In that scenario, the maximum payout to the trader would be the difference between the strike prices minus the premium paid. The key difference is digital options will pay maximum payout as long as the target level is met or exceeded, while the vertical spread will only pay out the maximum return if price exceeds the outer strike zone. The vertical spread will pay out partially if price settles somewhere between the two strike prices.